Real-estate investments can be rewarding - and risky

Just as investing in mutual funds, stocks, and GICs is personal, so is the decision to invest in real estate. It pays to first weigh all your options and compare it to other forms of investing.

Photographed by:Andy Dean, Fotolia.com

A curious reader recently asked me, "Is real estate a good investment these days?" Unfortunately, the answer to this great question is not really a clear yes or no.

Personally, I've had a very positive experience with real estate as an investment, but not everyone shares that. In fact, in his latest investment newsletter, Pat McKeough (the man behind The Successful Investor Network) says, "If you buy real estate as an investment, you may discover that there are greater risks, and more work, than you bargained for."

Just as investing in mutual funds, stocks, and GICs is personal, so is the decision to invest in real estate. It pays to first weigh all your options and compare it to other forms of investing. Let's explore some of the considerations involved.Leverage

A mortgage is a very common component of investing in real estate. It can be easier to get financing for real estate than for stocks because real estate tends to be less volatile and easier to appraise. Investing in real estate has a long history, which makes it easier for banks and financial institutions to analyze their risks. Its value also rarely drops drastically overnight, as some stocks do from time to time. It's important to remember that while leverage can enhance returns, it also can enhance risk.

Other costs

When investing in real estate, it's important to be aware of all the associated costs and fees, including commissions, lawyer's fees and other costs related to the buying and selling of a property. Also keep in mind the extra costs - such as property taxes, maintenance costs, utility costs and financing costs like the mortgage - that arise once you own the property.

While there are also costs associated with investing in stocks, mutual funds and securities, there are not quite as many variables at play.

Cash flow

Whether there will be a positive cash flow on your property should play a major role in your investment decision. In order for a property to provide cash flow, the rental income must be higher than the mortgage, taxes, maintenance and other expenses.

If you have to subsidize the investment, then you are probably in negative cash flow. I've had a number of people show me their real estate investment proposals and for the most part here in Alberta, real estate is not producing overly positive cash flow, unless there is very little debt on the property.

I will often make comparisons to a dividend stock or dividend fund. If I think it's reasonable to get a three or four per cent dividend, then a real estate investment has to provide at least a four per cent net rental income, otherwise the dividend investment will likely provide a better cash flow.

Some would say I am ignoring the possibility of capital appreciation, but in fact there is capital appreciation opportunity with both the real estate investment and the dividend based investment. Which will do better? No one really has the perfect crystal ball.

Time and effort

Real estate investing requires some sweat equity. You will have to spend time dealing with tenants, arranging for maintenance, doing the accounting and so on. You can hire others to do these tasks for you, but that will have a negative impact on cash flow.

If I had to choose between making a four-per-cent dividend with very little time and effort, or making four per cent income on a rental property but having to deal with tenants and maintenance, I would opt for the easier path. What about you?

Risk and reward

Just like stocks, real estate comes with risk. For example, real estate has liquidity risk - it's harder to sell than stocks, mutual funds or other investments.

There are certainly people who get stuck with properties that do not provide cash flow and that they have trouble selling for the profit they want.

On the other hand, some of the wealthiest people in the world have built their wealth and fortunes with real estate investing. Like most things in life, what you put into it is what you are likely to get out of it.

Before you invest in real estate, remember there's risk involved, as well as the potential for a lot of hard work, so put a little time, research and effort into making the right investment decision.